How to prepare with Treasury inflation-protected securities. July 31, 2009 Investors today can fight inflation with a tool that wasn't available when prices went wild in the 1980s: Treasury inflation-protected securities. Although TIPS pay interest just twice a year, the principal value adjusts monthly (with a two-month lag) in response to changes in the consumer price index. A higher principal value also lifts interest payments. The principal value can fall in the case of deflation (lower prices). But if you hold TIPS to maturity, you're assured that you'll get back at least what you put in. Like traditional Treasuries, TIPS are guaranteed by Uncle Sam's full faith and credit. RELATED LINKS What You Need to Know About Inflation 7 Ways Your Money Will Never Be the Same In early June, TIPS maturing in ten years yielded 1.9%, and regular ten-year Treasuries yielded 3.9%Qa gap of two percentage points. Experts call the difference the "break-even inflation rate," meaning investors anticipate annual inflation of roughly 2% over the next ten years. That's still low, although the spread has been increasing lately as investors stop fretting about the possibility of deflation. The numbers also tell you that if inflation averages more than 2% annually over the next decade, you'll do better with TIPS than with straight Treasuries. You can buy TIPS through brokerage firms or directly from the government's TreasuryDirect program. The minimum investment is $100. Advertisement If you prefer to buy through a mutual fund, our favorite is Vanguard Inflation-Protected Securities (symbol VIPSX), a member of the Kiplinger 25. Over the past five years through June 5, the fund returned 4.4% annualized. But be aware that TIPS funds can lose money, particularly when deflation rears its head. The Vanguard fund lost 2.9% last year; the average TIPS fund shed 4%. Given the link between inflation and commodities, putting some stuff in your portfolio may be a smart idea. Plus, commodity prices normally don't move in tandem with stock and bond prices, so adding commodities can reduce a portfolio's volatility while giving you an opportunity to boost returns. Our top pick is Pimco CommodityRealReturn Strategy (PCRDX), another member of the Kiplinger 25. If inflation heats up, bond yields are sure to rise as well. So an aggressive way to bet on inflation is to buy a fund that rises in value when yields rise (and prices fall). One such fund, ProFunds Rising Rates Opportunity 10 (RTPIX), seeks on a daily basis to move in the opposite direction of the price of the ten-year Treasury note. The fund does not employ leverage. If you want to make an even bigger bet against bonds, you can buy inverse exchange-traded funds. For example, ProShares UltraShort 20+ Year Treasury (TBT) seeks twice the opposite daily return of a long-term bond index. Just make sure you read The Perils of Leverage before investing.